Recovery expected to spur inflation But some economists predict price level will remain low.

March 30, 1992|By Sylvia Nasar | Sylvia Nasar,New York Times News Service

NEW YORK -- Although last week's report on gross domestic product showed that inflation has been extraordinarily low lately, most economists expect prices to revive along with the economy.

For example, the recent Blue Chip consensus of 50 forecasters was that the nation's price level would rise about 4 percent a year, twice the rate of the last nine months, for the rest of the decade.

But some contrary Federal Reserve officials and private economists think that inflation is likely to stay as low as it did during the 1960s, around 2 percent.

"We have a good chance to achieve effective price stability in America by mid-decade," Fed governor Lawrence B. Lindsay told members of the Government Bond Club of New England two weeks ago.

If he is right, some of the consequences could be unexpected. Most startling, lower inflation would have the same impact on the economy as a supply-side tax cut aimed at raising savings and investment.

"There is a widespread consensus in the economics profession that higher rates of saving and capital accumulation would be beneficial to the U.S. economy," said Mr. Lindsay, once the most prominent supply-side economist in the Bush administration. "Disinflation would produce much the same result."

Few members of Mr. Lindsay's under-40 generation of public finance experts would disagree. "We have a tax system that is not indexed for inflation," said James Poterba at the Massachusetts Institute of Technology. "Inflation raises the tax burden on capital."

Lawrence A. Kudlow, chief economist at Bear, Stearns & Co., agreed. "Very few people consider the tax implications of the inflation rate."

A permanent drop in inflation raises the after-tax returns of savings and investment. The reason: When Congress revised the tax code in the mid-1980s to eliminate "bracket creep," which forced taxpayers to pay higher income taxes merely because inflation had swelled nominal incomes, it did not do the same for most investment income.

Owners of bonds or real estate, for example, must pay taxes on nominal gains, which merely reflect inflation.

Consider how lower inflation would slash capital gains taxes. The capital gains tax rate is 28 percent. However, with 4 percent inflation, the effective tax on the real gains from selling an asset held for three or four years is more than twice as high.

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